Funding of private-sector defined benefit plans has been a rising tide. But why? And what does it mean? Two industry experts offer their insights in a deeper dive. 
The State of Things
“Funding levels for private sector pension plans are very healthy—most plans are fully funded or overfunded at the moment,” Sweta Vaidya, FSA, CFA, EA, Head of Solution Design North America at Insight Investment, told ASPPA Connect. Brian Donohue, Partner at October Three, enthusiastically observes, “Private-sector pension plans are the healthiest they have been all century.”
Donohue goes into more detail. “Among Fortune 500 employers, aggregate funded status improved from 89% at the end of 2019 to 100% at the end of 2022, erasing a $166 billion shortfall reported at the end of 2019. This trend is repeated in the broader private-sector pension universe and has continued into 2023, as most plans enjoy improvement of 5% or so this year,” he told ASPPA Connect.
The factors that have resulted in strong funded levels have had a broad effect, Vaidya suggests, remarking, “Overall, a rising tide has lifted all boats.”
But both Vaidya and Donohue do report that high funding levels are not uniform. Vaidya notes that it “varies across sectors.” Donohue elaborates: “banks and insurers tend to have well-funded pension plans while hospitals struggle with underfunded plans disproportionately.” He did not offer a suggestion regarding why that is the case, remarking, “It’s difficult to say why this is, possibly related to company capital structure, labor costs, and/or industry prospects.”
Challenging Times
So why is funded status so strong during a time of inflation and economic challenges?
Donohue suggests that pension plans are at least to some degree impervious to inflation, saying, “Private-sector pension promises are largely fixed in dollar-terms; to this extent, employers are not exposed to inflation risk.”
Both he and Vaidya consider interest rates and their interaction with other economic factors key to the strength of private pension plan funding levels. “The main driver of corporate pension funded status improvements over the past couple of years has been the increase in interest rates,” says Vaidya. “We are seeing the highest interest rates in 16 years; the 30-year Treasury bond closed at a 5% yield on Oct. 18 for the first time since August 2007,” observes Donohue.
The rising interest rates, says Vaidya, “increased discount rates used to measure pension liabilities and therefore significantly decreased those liabilities.” She continues, “Plan sponsors that were not hedging liabilities by holding a lot of interest-rate sensitive assets (i.e. fixed income) did not necessarily see a commensurate decline in assets—and therefore funded status improved.”
Donohue notes that “Higher interest rates, whether related to inflation or not, reduce pension liabilities.” He continues that “while interest rates have spiked from all-time lows at the end of 2019, stock markets have held up pretty well, producing a dramatic improvement in pension balance sheets.”
Assets and Liabilities
What is the relative importance for private-sector pension plans of trends concerning assets and those concerning liabilities? Is one more important than the other?
Neither Vaidya nor Donohue think there is any difference in the significance of assets and liabilities in the fortunes of pension plans. “Both asset and liability trends are equally important for private sector plans,” says Vaidya. Donohue struck a similar tone, remarking, “It’s hard to separate the two.”
Both also argue that investment and stock market activity influence and affect both—as well as funding levels.
“Equities have been particularly volatile lately and some plan sponsors with significant equity exposure have experienced asset losses and not necessarily seen funded status improve,” says Vaidya. She continues, “Investors that have diversified some equity risk with alternative investments generally fared better.” Donohue notes that a portfolio is relevant to liabilities as well. “Pension liabilities behave like bonds and LDI strategies exploit this characteristic to build portfolios that can ‘immunize’ pension liabilities,” he observes.
The Crystal Ball
As for what the rest of 2023 and 2024 portend, Vaidya anticipates that “investors that have decreased risk by better aligning assets with liabilities are likely to see fewer surprises due to lower funded status volatility.”
Donohue says “as funded status improves—especially for frozen pension plans—it often makes sense to rotate toward a portfolio that tracks the pension liability, so I would expect to see more employers moving along this path given the improvement in funded status we have seen.” He adds that he “would be surprised to see long-term interest rates continue to move higher.”
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